Tim Cestnick is president of WaterStreet Family Offices, and author of several tax and personal finance books. tcestnick@waterstreet.ca
Perhaps you've heard of Jon Jacobs, the resort entrepreneur. He hasn't made money with resorts in the real world, but in the online make-believe world of Planet Calypso. The gamer sold his make-believe real estate for $635,000 in real U.S. dollars, achieving a 35-per-cent annual return. Apparently, a study by the firm In-Stat suggests that online videogame players will invest billions in make-believe property and goods each year.
Those are crazy returns from a crazy investment. If you happen to be an investor, you're no doubt looking for ways to increase your returns. Look no further than your own tax return. If you can achieve tax savings related to your investments, this will increase your after-tax returns. So, consider the following ideas when filing your tax return this year.
Claim interest costs. If you've borrowed money for the purpose of earning "income from property" (call this the "purpose test") then you'll generally be able to deduct your interest costs. Income from property includes rents, royalties, interest or dividends.
What about capital gains? The federal government generally takes the view that an investment without a stated interest or dividend rate – such as most common shares or mutual funds – will typically give rise to interest deductibility on the basis that there is an expectation of dividends or interest in the future. If you invest in something that has absolutely no opportunity to provide income – just capital growth – you may run into a problem deducting interest costs if you've borrowed to make the investment. When it comes to deducting interest, don't forget to check your brokerage statements for any eligible interest you might have paid.
Allocate fees to non-registered accounts. If you're paying fees to your investment adviser, consider the allocation of those fees between your registered plan accounts (RRSP, RRIF, TFSA) and your non-registered accounts. Fees related to your registered accounts are not deductible, but fees on your non-registered accounts generally are. If your adviser spends much more time and effort to manage your non-registered accounts, he may be able to allocate a greater portion of his fee to those accounts.
Report your spouse's dividends on your return. If your spouse has received dividends from Canadian securities, but has little income, he may not benefit much, if at all, from the dividend tax credit that he's entitled to claim. In this case, you can report the dividends on your tax return. You'll be entitled to a higher spousal tax credit because your lower-income spouse will now have less income to report (in fact, you can take advantage of this idea only where it's going to result in a higher spousal credit for you). In the end, you'll pay less tax as a couple.
Claim a business investment loss. If you own shares in, or have lent money to, a small business corporation, and the business has gone sour, you may be able to claim an "allowable business investment loss." This is calculated as 50 per cent of the money lost by you, and can generally be deducted against any type of income – not just capital gains – although some restrictions may apply where you've claimed the capital gains exemption in the past.
Consider capital versus income treatment. In some cases you may have the option between reporting your investment profits as business income, or capital gains. First, if you can argue either way, you'll generally prefer capital gains treatment if you have profits because just 50 per cent of capital gains are taxable. If you have losses, on the other hand, business losses can be applied against any type of income while capital losses must be applied against capital gains.
The problem? You can't simply report your profits as capital gains and your losses as business losses. The taxman expects consistency. Generally, if you can answer "yes" to many of the following questions, the taxman may consider income rather than capital treatment to be appropriate.
1. Did you complete many transactions?
2. Did you intend to buy and flip the securities for a profit?
3. Did you hold the securities for a short time?
4. Were the securities of the quality you would not hold for long?
5. Did you devote significant time to stock market transactions?
6. Did you borrow much to make the investments?
7. Do you have special knowledge or expertise in the securities market?
Tim Cestnick